Bitcoin

“A cynic is a man who knows the price of everything, and the value of nothing.” -Oscar Wilde

I’ll never forget 2008. It was the worst market I’d ever seen, and I hope that never changes. The speed of the sell off was so quick, it felt like a new company went bankrupt every day. And every time we thought it found a floor, it fell further. Unemployment rates around the globe spiked, even the impenetrable money market funds we’re showing cracks in their foundations... I remember standing in front of a Citibank with my paycheck, just staring at the ATM and wondering if I should deposit that check there, because I wasn’t sure it (or any bank) would be around in the near future. There was a fear in the pit of my stomach that i’ll never forget. It felt like the end of the financial system as we knew it. 

People were questioning whether diversification made sense, they were questioning every fee they paid, they were even questioning investing in general. And it was logical to do so; if you invested in the S&P in 1998, and held ten years to the crash of 2008, you lost about 26.5% (1). To add insult to injury, most Americans largest store of wealth has always been their houses. And this recession came for those prices with a vengeance. House prices slumped 30-35% in most markets, Phoenix fell 50%, and Las Vegas was down close to 60%! Nothing made any sense anymore. Years later it became a running joke that everyone told fish stories about how well they held up in 2008. But I’m here to tell you, everyone managing assets was terrified. And with the exception of a few very intelligent hedge funds, everyone lost money. 

Like a white knight, in rides Warren Buffet. The model of prudent investing had been stockpiling cash for years prior to the crash. As the buildings were burning he came in buying up all the wreckage he could, and he got fire sale prices. Be bailed out Goldman Sachs, he bailed out Wells Fargo, he told his boards what to do, he consulted the President, even the Federal Reserve. I remember being so astonished by his conviction. Not only did he know to de-risk his portfolios BEFORE the crash, he now seemed so confident to step back into the fray. 

The reason for his conviction was not his brilliance, or his patience. Though both are legendary. No, he was so confident because he is a man who understands valuations. And while it may sound simple, determining what something is “worth” isn’t always an easy question to answer. The most basic answer is “whatever someone ELSE is willing to pay for it.” But that’s misleading, if only one person overpays for something, who will they sell it to? If there’s ten of an identical item in a store, and the store clerk cons someone into paying triple for one of the ten, has he changed the value of the other 9? 

Fortunately as with most financial vehicles, we can plug in some pretty useful equations, to help us understand a securities value. You can use these numbers to compare it to itself and its peers, over time. One common metric is called “Price-to-Earnings” ratio. It’s exactly as simple as it sounds. You take a stocks price per share, and divide it by its earnings per share. So if Goldman Sachs is currently trading at $854.56 and its earnings per share are $49.22 (for each share you own, the company gives you $49.22 of its earnings) then your P/E Ratio is 17.362. So today, the price you pay per share is 17.4 times the earnings. What if they come up with some insane new derivatives equation, or trading software that grows their earnings exponentially? Now assume they’re earning $854.56 a share. If the stock price stayed the same, you’d have a P/E of 1. Clearly you can see why you’d want that number to be lower. You get more earnings for the price you’re paying. What if their EPS went to 854.56 like the example before, but this time their same ratio held true? The expected stock price would be $14,869.34 (6).

It may seem complicated at first glance, but it’s very simple equations like this that Buffet used to gauge whether he was getting a good value or a bad one, for what he was buying. He was unloading stocks and raising cash when the P/E’s were high, and when he came in to buy everything he could, most of them held single digit P/E ratios. They call him the “Oracle of Omaha” implying he can see the future, but all he really sees is value. You buy a company to get its earnings, if a bunch of stocks gave you one twentieth of their stock’s price in earnings yesterday, and one fifth of your stock’s price in earnings today, you should buy a lot today. Ok, well cool story, but what the hell does any of that have to do with crypto currencies??? And that’s where I need to switch to opinion.

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I have a very hard time when I meet people (and I know a good amount), who have Buffett level conviction with crypto currencies. Not because I think they’re right or wrong, but because I have such a hard time determining valuations of crypto currencies. In contrast to the example above, buying bitcoin doesn’t entitle you to their “earnings.” There’s no company, even. So what exactly is it?

Crypto currency at its very base form is a math equation. I’m dramatically oversimplifying, but let’s say I have one bitcoin and I want to give it to you. I send you the pieces of the math problem that establishes I own the bitcoin, a bitcoin miner then checks the equation and he or she approves the transaction, they get a kickback for checking our work, the equation then grows to include the information that you now own it. Again, I’m speaking hyperbolically to illustrate my point, but when it starts it may be 1+1=2. I give you my bitcoin, the miner looks at the equation and says “yup, 1+1=2” and adds a few more numbers showing he checked our work, and some data that the coin now belongs to you. So the equation becomes 1+1=2+8=10. Then you trade it to someone else and the equation is now: 1+1=2+8=10/3+15=18.333. We’re two transactions in, and the equation has already gotten much more complicated than where it started. But that’s it, that’s crypto in a nutshell. 

It was designed to be a currency, and frankly it’s pretty brilliant in that. Math equations transcend boarders, they’re free from the busy hands of politicians, there’s no foreign currencies to worry about. If the question you’re asking is, “does the world have a demand for a digital currency that can do all the things that I just said bitcoin does?” The answer would be a resounding “yes!” But the CFA defines an effective currency as being able to do three things. 1) it must be a medium of exchange. Meaning if has to be widely accepted by users in transactions. Beaver pelts for example aren’t “widely accepted” for exchange, so they would not qualify. Most places take US Dollars however, so they would qualify. 2)  it must be a unit of account. Meaning it must be widely understood what its value is. People aren’t going to let you use bitcoin to by a pizza today, if that same bitcoin is worth either half a pizza or two pizzas tomorrow. And you’re likely not going to use it to buy a pizza today if you can use that same bitcoin to buy 80,000 pizzas next week. Lastly 3) it must be a store of value. Meaning people can save it, and not have their purchasing power decrease over time.

So where does bitcoin rank in those 3? I’d maybe give it a C- letter grade. Is it a medium of exchange? Sort of, some places accept it. But you can’t walk into a Safeway and use it to buy groceries. And companies that have tried to use it as a currency have reversed course on that decision pretty quickly. As an example, in 2021 Tesla accepted bitcoin as payment for a few months, ultimately reversing course because of “climate concerns” according to the article cited in footnotes (5), but it’s likely no coincidence that the swings in value while they held it were wild and unpredictable. That said, places still do use it for exchange, specifically overseas transactions, or for less reputable sites like gambling, or rocket launcher purchases, or whatever. 2) Is it a unit of account? Not really. Everyone likes to talk about bitcoin’s unprecedented growth, but very few people got in on the ground floor. Most people bought somewhere in the last 7 years after its astronomical growth in 2017 (over 1300%), and since then it’s been extremely volatile. At one point in 2018 its standard deviation was 100%, that’s not investing, that's playing roulette. You had an equal chance you’d lose your whole investment, or double it. Since then it’s came down to around 50% but that’s still very high. Around five times as volatile as stocks, and around 3.6 times as volatile as gold(4).

Volatility may make you lots of money when you’re right, but because of the asymmetry of returns (2), it’s a losing game in the long run. Look no further than 2025, as of the writing of this, it’s down 31.8% YTD (it takes me a few days to write these posts, I’ve had to double that number since I started). I guess you could argue that you usually “know” its value, and that value is “agreed upon”. Thus making it a unit of account. But that’s a bit of a stretch, no one knows its price at all times. And its price swings dramatically even at night, or on the weekends. And 3) is it a store of value? Depends when you ask. Not this year, but to be fair the same could be said to a much lesser extent for the dollar. So again, kind of? The central issue here is that its volatility makes it very hard to work with. Assume you have to pay for something in bitcoin, and you have the exact amount in your wallet, but you have to pay for the item in two weeks, how confident are you that you’ll be able to make the transaction? I think this is a “no”.

So where does this leave us on bitcoin being a currency? Is it a) widely accepted (not really) b) universally understood (sort of) and c) stable price. (No). Lastly, let’s touch on the “climate concerns” Tesla cited in the brief window they were using it. He’s referring to the exponential growth of these equations we talked about before. When bitcoin started, “mining” those equations was relatively easy. The computer power was low, and the power draw for mining was minimal. A billion transactions later, those equations are a mile long and those power draws are immense. Bitcoin now requires more power than the entire country of Poland, or Argentina. In fact, it’s estimated that half a percent of ALL the power used on planet earth, goes to bitcoin mining (3). And that pill gets harder to swallow by the day. If you’re planning to use this for billions of more transactions in the future, how will it handle that power draw? Bitcoin’s proponents argue that computing power will rise to meet the needs, and that may be true. But it also may not be. How can you know for sure without knowing the exact (or even approximate) amount of bitcoins needing to be mined? Whether they’re right or wrong doesn’t change the fact that, it’s a complete guess. But it’s an integral part of this problem. So we have to deal with the information we have today, and it doesn’t look very scalable. At least not with today’s technology.

So if it’s not a currency, what is it? Is it a speculative asset, like gold? I can see that argument. The difference is that gold has mechanical uses, electronic applications, even virtue when making jewelry, or medical equipment. It’s also been used as a currency for much longer, and across a wider group of people. What’s the “need” for bitcoin? It doesn’t really “do” anything. It has value because people think it has value. And fortunes have certainly been made from far less. But from an investment standpoint, there’s really nothing else there. Even if you were to make the argument that it IS a currency, and there’s definitely a demand for that. You’d have to keep in mind that it’s far from alone in pursuing that endeavor. There are literally thousands of other crypto currencies, many of which claim to have solutions to the “climate concerns” issue. Before you tell me about its “first mover advantage” in the crypto market, keep in mind that that’s a fickle mistress in tech, just ask MySpace.

Which brings us back to Mr. Buffett. How do you buy something if you can’t determine its value? How do you know the price you’re paying - for whatever this is - is a good one? Just “hoping” other people continue to think this math equation has value is not an investment strategy, no matter how long that’s worked in the recent past. Not only is Warren a genius at finding what something is worth over the long term, he’s a staunch opponent of bitcoin. His famous analogy was “if you owned all the farmland or apartments in the world, you’d be a trillionaire. If you owned all the bitcoin in the world, its value would drop to nothing and you’d have zero net worth because bitcoin doesn’t do anything.” (7). And I’d assume he has a better grasp on this than the bagger at the grocery store, or whoever told you it’s a great investment. 

In closing, while I think there’s a huge demand for a digital currency in application, there’s too much risk in selecting just one. Especially one that’s had such an insane appreciating, and is a ticking time bomb from a power consumption standpoint. For the sake of brevity we haven’t even mentioned regulatory risk (this administration has done everything it can to help crypto, that may not always be the case), technology risk (maybe something better comes along), or security risks (hacking or fraud). The issue in selecting an asset that has had such a meteoric rise, is that you’re more vulnerable to all those unknown risks. Just as Buffett didn’t know what risks were on the horizon when he was selling stocks in 2005 and 2006, he was selling because their inflated valuations made them vulnerable. My target price for bitcoin is significantly below where it’s at now. At least until (or if) you see some price stabilization and some solutions to its exponential power draw, thus improving its efficacy as an actual “currency.” Because whatever is it now, I’m not interested. 

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(1) On December 31st of 1998 the S&P500 close was 1229.23-December 31st 2008 the close was 903.25=325.98 & 325.98/1229.23=0.265

(2) “asymmetry of returns” is a term used to illustrate that losses have an outsized effect on your portfolio return when compared to an equal upside. As an example, if you have $100 and you lose 50% in year one, you now have 50 dollars. Make the same 50% back in year two and you now have 75 dollars. You lost 25% total in two years even though you had the same gain and loss year over year. It’s a term used to explain why lower volatility is better for long term success.

(3) https://buybitcoinworldwide.com/bitcoin-mining-statistics/

(4) https://buybitcoinworldwide.com/bitcoin-mining-statistics/

(5) https://www.bbc.com/news/business-57096305

(6) Formula for P/E Ratio

The formula is simple:

\[ \text{P/E Ratio} = \frac{\text{Price per Share}}{\text{Earnings per Share (EPS)}} \]

 Steps to Calculate P/E Ratio

1. **Determine the Price per Share**:

   - Find the current market price of the stock. This data can typically be found on financial news websites or stock market platforms.

2. **Calculate Earnings per Share (EPS)**:

   - **EPS** can be calculated using the formula:

     \[ \text{EPS} = \frac{\text{Net Income} - \text{Dividends on Preferred Stock}}{\text{Average Outstanding Shares}} \]

   - Alternatively, EPS figures are often provided in a company’s financial statements or earnings reports.

3. **Plug Values into the Formula**:

   - Once you have both the price per share and the EPS, substitute these values into the P/E ratio formula.

### Example Calculation

Let’s say:

- **Price per Share**: $100

- **Earnings per Share (EPS)**: $5

Using the formula:

\[ \text{P/E Ratio} = \frac{100}{5} = 20 \]

### Interpretation

- A P/E ratio of 20 means investors are willing to pay $20 for every $1 of earnings. 

- **High P/E Ratio**: May indicate that the stock is overvalued or that investors are expecting high growth rates in the future.

- **Low P/E Ratio**: May suggest that the stock is undervalued or that the company is experiencing difficulties.

### Key Takeaways

- The P/E ratio is a fundamental valuation tool used by investors.

- It’s important to compare the P/E ratio of a company to its peers and the industry average for a better analysis.

(7) https://www.cnbc.com/2022/05/02/warren-buffett-wouldnt-spend-25-on-all-of-the-bitcoin-in-the-world.html